The Morningstar Economic Moat Rating

The Morningstar Economic Moat Rating represents a company’s competitive advantage. An economic moat helps a company fend off competition and earn high returns on capital for many years to come.

Morningstar identified five sources that build and widen a moat:

1. Switching costs are obstacles that keep customers from changing between products, like from one company’s product to a competitor’s.
2. Network effects occur when the value of a good or service increases for both new and existing users as more people use it.
3. Intangible assets are things such as patents, government licenses, and brand identity that keep a company ahead and competitors at bay.
4. A company with a cost advantage can produce goods or services at a lower cost, allowing it to undercut its competitors or achieve higher profitability.
5. Efficient scale benefits companies operating in a market that only supports one or a few competitors, limiting rivalry.

If we can expect a company’s competitive advantage to last more than 20 years, we consider it as having a wide moat. If it can fend off rivals for 10 years, it has a narrow moat. If a competitive advantage doesn’t exist or may prove fleeting, there’s no moat.

When searching for undervalued companies, those with narrow or wide economic moats often offer attractive return potential. The Morningstar Economic Moat Rating can help you identify those companies to provide superior long-term returns.